TAX DEDUCTIONS ON REFITTING PREMISES

TAX DEDUCTIONS ON REFITTING PREMISES

BY YEN-PEI CHEN,

CORPORATE REPORTING AND TAX MANAGER AT THE ASSOCIATION OF

CHARTERED CERTIFIED ACCOUNTANTS (ACCA)

Investing money to fit out a practice is crucial for bringing in patients but, come

tax return time, complex tax rules might make your investment feel more like a curse than a blessing. Electrical wiring, plumbing, lighting or x-ray protection may all be

subject to different tax treatments depending on specific circumstances. To make sure

that you are getting the most out of the tax deductions available, good record-keeping

and some forward planning are essential. If your refitting costs are substantial, it’s well worth taking qualified tax advice.

So, what are the rules?

REPAIR OR IMPROVEMENT?

The first thing to get straight is whether your refitting costs relate to repair or improvement. The distinction might seem pedantic, but they make all the difference. If the costs relate to repair, they are deductible as an expense from your taxable profit. If the costs relate to improvement, however, the taxman considers them to be capital

expenditure: as such, no deductions from taxable profit are allowed.

Essentially, replacing or fixing something to get your practice back into working order is fine as repair, but do anything further and you could stray into the clutches of

capital expenditure. The fact that you have a maintenance problem that must be dealt with doesn’t necessarily make your refitting costs deductible as repair – the taxman will want to know what actually happened.

HMRC’s manual, written to guide to HMRC inspectors as they scrutinise tax returns, gives the example of a company that needed to have its roof repaired and decided to open up the roof area for extra office space. The fact that the roof was unsound and needed to be repaired was beside the point: the additional work that got done on the roof makes what happened improvement, not repairs.

HMRC also gives the example of a shop owner who had a new shop front put in when he took over the premises. The replacement of a shop front would normally be deductible as revenue expenses, but the fact that the shop owner adapted the shop front to his specific needs makes it an improvement, and therefore capital expenditure.

STOCK OR FIXED ASSET?

Whether your practice fittings count as fixed assets or stock determines how you will be taxed when you sell the assets on. The sale of stock is taxed as taxable income; the sale of fixed assets is taxed as a chargeable gain, which could be reduced using indexation allowance (if you operate through a company) and other tax reliefs.

Because tax on chargeable gains usually works out as less than tax on straight income, there is a long history in case law of businesses trying to get disposals of various assets to be taxed as chargeable gains.

The key question that HMRC will ask is: “what is the nature of the business?” If, for example, you sell kitchen units, then HMRC would assume – barring strong evidence

to the contrary – that the kitchen units displayed in the showroom were intended for sale, and therefore were trading stock. But as you serve patients with some tangential retail sales you are unlikely to have any problems here; clearly practices aren’t in business to sell dental chairs or autoclaves.

CAPITAL ALLOWANCES ON CAPITAL EXPENDITURE

It’s time to look at the other refitting costs – the capital expenditure.

The good news is, if you can’t claim revenue deductions on your refitting costs, you may still get tax deductions in the form of capital allowances. The Annual Investment Allowance (AIA) allows you to claim tax deductions on the full amount of qualifying expenditure, up to £200,000. This is available on both plant and machinery and integral features, which we will look at in turn below.

Over and above the AIA limit, lower capital allowances are available each year, on a reducing balance basis. This is currently at 18% for plant and machinery and at 8% for integral features.

There’s an easy tax planning point here: Prioritise integral features over plant and machinery when making AIA claims. This is because capital allowances are available at a lower rate for integral features, so the more integral features you can get 100%

AIA on the lower your tax bill will be. Just watch out when the Government changes the threshold for AIAs in the middle of the tax year – when this happens, you will need to identify which assets are acquired before, and after, the change.

PLANT AND MACHINERY

To qualify as plant and machinery, the expenditure has to:

• be kept “for permanent employment in the business”: in other words, this excludes stock you retail or expendable equipment with a life of less than two years;
• and function as “an apparatus employed in carrying out the activities of the business” and not as part of the premises in which the business is carried on.

The second point needs a bit of unpacking. Whether something consists of the apparatus used in carrying out the business or the business premises is surprisingly hard to pin down in case law.

In one memorable case, Benson v The Yard Arm Club, a company opened a floating restaurant on an old ship and claimed plant and machinery capital allowances on the ship, arguing that it was the restaurant’s unique selling point. This was refused in the courts: the ship was the structure within which the restaurant business was run. In the words of the Court of Appeal judge, he could see no distinction between “a restaurant  on the Thames and a fish and chip shop in Bethnal Green. Both act as premises in which the trade is carried on.”

The basic principle is that anything which can reasonably be expected to form part of your practice building – for example, walls, partitions, ceilings, floors, doors, windows and lighting – should be considered to be premises and not plant. There might be exceptions if they are moveable, and/or designed to fulfil a special function. If this is the case, consider speaking to a tax advisor.

The UK’s tax law around the kinds of assets that qualify as plant and machinery is very specific, and sometimes counterintuitive. Sections 21 to 23 of the Capital Allowances Act 2001 sets out a list of things which definitely are, and which definitely aren’t, plant and machinery. However, if your refitting costs are large enough to send you scurrying to the tax books, you may sleep better if you speak to a professional accountant or tax advisor.

INTEGRAL FEATURES

If the above criteria for plant have let you down, don’t despair! Special rate allowances are available on assets which are integral to buildings, including electrical systems (including a lighting system), cold water systems, space or water heating systems, powered systems of ventilation, air cooling or air purification, any floor or ceiling in such a system, and external solar shading.

Electrical systems are not defined in legislation, so the taxman will be looking to the ordinary meaning of the term: “a system for taking electrical power (including lighting) from the point of entry to the building or structure, or generation within the building or structure, and distributing it through the building or structure, as required.”

It’s worth considering what you’re putting the electrical systems in for. If an electrical system is installed purely to support qualifying plant and machinery – burglar alarms or an x-ray machine, for example – the cost of the electrical system counts as plant and machinery, and will be eligible for the higher plant and machinery allowances. One supermarket chain got plant and machinery allowances on nearly all their electrics, since most of it was there to run freezers for food storage. They even successfully argued that their lighting had to be bespoke, so that also qualified for plant and machinery allowances.

RECORD-KEEPING

One final piece of advice: keep clear records, and separately identify each item of expenditure.

Rather than amalgamating all your costs under one-line item called “practice fittings” in your tax return, you will have a much better chance of claiming capital allowances successfully if you break down your costs into specific headings – treatment equipment, lighting, and electrical wiring for air conditioning, x-ray machines and plumbing. Likewise, when you claim for a revenue deduction on repairs, be prepared to back up your claim with invoices and a breakdown of the works carried out if and  when the taxman asks you for details.